Protecting Against Downside Risk As Retail Stock Report Earnings

| February 21, 2018 | 0 Comments

retail stockThe increase in market volatility the past couple weeks is helping to reawaken interest in hedging with options. More specifically, I’m seeing a lot more downside protection trades in the options market than before the correction at the beginning of February.

Investors have quickly remembered that stocks can move really fast when things get hairy. With the VIX (the S&P 500 Volatility Index) up near 20 (it was about 10 in January), we’re seeing more volatility than we’ve experienced in quite some time. More volatility comes with uncertainty, and the markets hate uncertainty.

One way to combat uncertainty is by hedging your positions. If you have a long stock portfolio, like most people, then using options to protect your portfolio is a smart and easy way to give peace of mind. Of course you can also hedge individual stocks or even hedge sectors.

For instance, this week we’re going to see a lot of big retail stocks report earnings. If you’re portfolio has exposure to retail stocks (and most do), then you could consider using puts on a sector ETF to protect against a selloff in the sector (due to bad earnings or otherwise).

The most popular retail sector ETF is SPDR Consumer Staples Select ETF (NYSE: XLP). It trades about 13 million shares a day on average and includes most of the key big name retail stores.

At least one big trader is taking an interesting approach to protecting against a down move in the retail sector. The trader is using a position that actually makes money if nothing happens, but can also pull in big bucks if XLP takes a dive.

Here are the details…

The trader sold the March 16th 55 XLP put for $0.95 7,500 times, while simultaneously buying 15,000 of the 53 puts for $0.36. XLP was just over $55 per share when this trade was made. The trade actually receives a credit of $0.23.

This trade is a called a ratio put spread because the trader purchased one put versus selling two puts. This type of strategy is unusual in that it can produce a credit, while also taking a strong directional bias in the underlying asset.

In this case, if XLP does nothing, the trader will earn the entire credit of $172,500. Max loss occurs if XLP moves to $53 at expiration. That’s because the long position (53 puts) would be worth nothing and the short position (55 puts) would also be losing money. However, below about $51, the double-long put position really kicks in and starts making money.

SPDR Consumer Staples Select ETF

You see, half the long puts would cancel out the short puts at that point, but the other 7,500 long puts would be pure profit all the way down. A position that size would generate $750,000 per $1 move below $51. So, it’s easy to see how this position can be considered a hedge.

While this trade is more advanced, it’s a really good way to earn money while also hedging major downside risk in the retail sector. If you feel comfortable with a more complex positon, I have no qualms with recommending a trade like this if you have exposure to retail stocks in your portfolio.


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Category: Options Trading Strategy

About the Author ()

Jay Soloff is an options analyst with Investors Alley.